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Salerno and Selgin on Deflation–and Quantitative Easing

In an interview on CNBC’s European Closing Bell show, George Selgin presents an eloquent and compelling defense of deflation that is caused by increasing productivity in the economy. He refers to this as “good deflation.” Indeed, Selgin argues that such deflation is “desirable,” because any attempt by the Fed to offset it by monetary expansion will create asset bubbles.

Unfortunately, in the same interview, Selgin defends the first round of quantitative easing undertaken by the Fed in 2008 on the Keynesian grounds of the necessity of offsetting a fall in total spending or “aggregate demand.” In Selgin’s words:

Back in 2008 a case existed for quantitative easing because there really was a shrinkage of demand and the Fed needed to do something about it. . . . It [quantitative easing] is sometimes flawed and sometimes not depending on whether it is in response to falling demand that needs to be revived, where it can play a role in reviving it under the right circumstances. . . .

Furthermore, Selgin correctly points out that arguments for the Fed targeting a stable price level or an inflation rate of two percent “aren’t founded on anything really sound.” And yet Selgin goes on to call on the Fed to target a constant level of total spending or “nominal GDP” in order to achieve his own preferred rate of price change for the economy. “According to my theory,” says Selgin, “a healthy rate of deflation is one that looks like productivity growth.” But why is this rate of change in overall prices any less arbitrary than, for example, the 2.5 percent increase in prices that Bernanke prefers? Why must changes in overall prices reflecting the public’s changing relative valuations of cash holdings vis-a-vis consumer and producer goods be eternally suppressed by the Fed, particularly falling prices resulting from an increase in the demand for cash?

In fact Selgin expresses a profound solidarity with Keynesian macroeconomists like Bernanke when he states in his interview that a shrinkage in the demand for goods is undesirable and must be avoided, whether by quantitative easing or by mandating that the Fed target a constant level of nominal GDP in the long run. Like Bernanke et al. it seems that Selgin has not learned the first principle of business cycles, which was originally discovered by the classical economists and elaborated into a full theory by Mises, Hayek, and later Austrian economists. The classical economist David Ricardo gave this principle concise and elegant expression:

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The Sound Money Project was founded in January 2009 to conduct research and promote awareness about monetary stability and financial privacy. It is a project of the American Institute for Economic Research.